2023-10-18 09:34:25 ET
Summary
- Harrow has provided long-term revenue guidance of $1B in 2027. If they deliver on this, the shares are likely to head north of $100. Perhaps a lot north.
- In order to deliver as promised, Harrow needs to succeed in its bold move into branded pharmaceutical products. Investors are looking for any signs of how well that's going.
- In this article, I examine the data we have so far and conclude that the early signs, while far from definitive, are good.
- In particular, early sales data show their potential blockbuster drug Iheezo is off to a great start.
- Harrow could help its case with investors by striking the right balance between protecting competitively sensitive information and being transparent with investors.
Harrow Inc. (HROW) has built a best-of-breed business in a small niche. Their legacy compounding business, ImprimisRx, has grown rapidly to become the largest ophthalmic compounding pharmacy in the US in only 9 years. The company's founder and entrepreneurial CEO, Mark Baum, has announced a bold plan to expand the company into the much larger branded pharmaceutical product [BPP] space, with the intention of growing revenue tenfold by the end of the decade.
HROW has spent heavily on the expansion, both by increasing the size of its salesforce and through acquisitions. SG&A expense has ramped up aggressively ahead of any new revenue, and the company has taken on debt to finance the acquisitions. New BPP products are beginning to impact revenue in 2023, and if things go as planned revenue will grow rapidly in 2024 and beyond. I've written about the long run goals of this expansion before and argued that a triple-digit share price is coming if they deliver as promised. Needless to say, a lot is riding on the success of the new initiative, and while it's impossible to say for sure at this early stage, investors nevertheless quite naturally want to know: how is it going so far? In this article I consider 2023 guidance, and results YTD, to try to answer that question.
HROW is a growth company
Before I dive in, it's worth noting that HROW has grown revenue enormously for many years. Growth is organic until 2023, the first year that M&A begins to move the needle. All numbers are in , and 2023 is the midpoint of guidance.
Year | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
Revenue | 9.7 | 19.9 | 26.8 | 41.4 | 51.2 | 48.9 | 72.5 | 88.6 | 139 |
HROW's expansion into BPPs
HROW has been very active, acquiring Iheezo , Vevye , a group of five drugs they call the " Fab 5 ", and Santen's Branded Ophthalmic Portfolio . I've argued before that these drugs will drive a tenfold increase in HROW revenue from 2022 levels in 2027. HROW can expect to begin receiving revenue from each of these new drugs as follows:
- The Fab 4 - that's the Fab 5 excluding Triesence - were acquired on Jan 23 2023, and the company began recognizing revenue at that time.
- Iheezo was just launched in Q2 2023. Note that newly launched drugs tend to start small and grow over time.
- Fortisite was also launched in Q2 2023.
- Vevye is expected to launch in Q4 2023. Very little if any revenue is expected in 2023.
- The Santen portfolio is likely to generate $1M or $2M in revenue in 2023.
- Triesence is expected to be available for sale in 1H 2024.
Iheezo revenue in Q2 2023
HROW has identified two drugs, Iheezo and Vevye, as their largest opportunities. From the Q2 2023 shareholder letter :
IHEEZO and VEVYE are our largest revenue opportunities - without question.
Of the two, Vevye has not launched yet and is not expected to make a meaningful revenue contribution until 2024. Iheezo launched May 5, 2023 , and it's very much on shareholders' minds to know what kind of start it's off to. Note that newly launched drugs tend to start slowly and then ramp up considerably. One example is Restasis, a competitor to Vevye, which achieved less than $100M of revenue in its first full year after launch but ramped up to over $1.5B in sales at its peak. Iheezo would be a massive hit for HROW at just 20% of that total.
Unfortunately, HROW does not break out revenue by the drug. However, in Q2 HROW had $33.5M of revenue, and I can't get to that number without a meaningful contribution from Iheezo. And here we are going to get into a bit of annoying arithmetic, apologies in advance, but I think it's important to walk through it.
In Q1, the legacy business produced $20.45M of revenue, and the Fab 4 produced $5.65M in 67 days (the acquisition closed Jan 23). Both of these numbers are reported in the Q1 2023 10Q on page 12, with the Fab 4 sales included as "transferred profit". That's a run rate on the Fab 4 of $7.7M of transferred profit on a 91-day quarter.
In Q2, this implies $21.3M legacy after adjusting for a 91-day quarter and assuming 3% Q on Q growth, in line with management's comments that the legacy business is growing low double digits. And then $8.1M of Fab 4. To get that Fab 4 number, I take the run rate from Q1 extended into 91 days, and then add in $400k because the NDA's transferred on the Fab 3 mid quarter. That last point adds about 10% to the revenue run rate on 3 of the four drugs, but only for two months. That's a revenue bump over transferred profit because now one adds in COGS, with gross margins of 90%.
Yeah, I know. I already mentioned I was sorry about the arithmetic.
Moving on, that's $29.4M of revenue in Q2 2023 if we just connect the dots in the simplest way for the Fab 4 and the legacy business. But revenue in Q2 2023 was $33.5M, and that means there's $4.1M of revenue from some other source.
So where, oh where did that $4.1M of unexplained revenue come from? There are only two other sources. HROW launched both Iheezo and Fortisite in the middle of Q2 2023, and... that's it. It probably can't be from the Fab 4 since we know that transferred revenue in both Q1 and Q2 is consistent with the estimate I have here. The legacy revenue could be a bit higher, but it would be pretty weird if it grew $5M in a single quarter, up 25% not annualized , with management telling us it's growing at a low double-digit annual rate. So I think we can reasonably conclude that of that roughly $4M in Q2, a meaningful chunk came from Iheezo and Fortisite.
And it's probably more Iheezo than Fortisite. I say this not only because Iheezo is expected to be a much bigger drug than Fortisite, by a factor of 10 or so, but also because Baum makes the following comment during the Q2 earnings call :
The revenue growth is being driven broadly speaking by our branded portfolio. That's VIGAMOX, it's MAXITROL, MAXIDEX, ILEVRO, NEVANAC, and of course IHEEZO. So that's where we're seeing the growth.
Now, I should point out here that Baum is answering a question about revenue growth for the year, not just Q2, but I do think if Fortisite were a big contributor in Q2, he would have included it in his answer. But Fortisite is not included in this list, and Iheezo is. So, in my view, the unexplained $4M in Q2 2023 likely includes a substantial contribution from Iheezo, perhaps at least half.
This is very good news given the way drugs tend to ramp aggressively over a number of years, and it's easy to imagine $5M to $10M of revenue from Iheezo in Q4 2023, and then $50M or more in 2024, the first full year after launch, and heading into multiple hundreds of or annual revenue over time. A true homerun if it does, in fact, actually go that way.
Bloomberg sales data
Bloomberg reports on Iheezo sales, among other drugs. Bloomberg gets their data from a company called Symphony, and Symphony's data is incomplete . One can easily confirm this by speaking with companies such as HROW and asking them if any data are missing, and indeed, the answer is yes, that can and does happen. Examples applicable to HROW include Iheezo sales in Q2 and Vigamox sales in Q3, both of which were meaningfully under-reported by Symphony.
But despite some gaps, Symphony data are broadly indicative of the sales trend, and in the case of Iheezo, that trend is up and to the right in a big way. Here's a screenshot:
Bloomberg
Although Symphony data is missing some sales, the trend is well up in September, with Symphony reporting roughly $1.8M if Iheezo sold that month. This data excludes the impact of rebates and discounts, and the actual revenue to HROW is likely about 20% lower when corrected for this, at about $1.3M.
Since not all sales are captured by Symphony, this is a lower bound, and the actual sales in September are best thought of as $1.3M or more . How much more is not known. I've already made the case that in Q2 there's likely at least $1M per month missing from this chart, but I will not speculate further on the matter here.
Of the data that are captured by Symphony, it's worth pointing out that we don't know when in September new customers came on board. And this actually matters! If new customers contributed $1M in September, and if these began purchasing, on average, in the middle of the month, then their contribution run rate by the end of the month would be $2M. So that means we actually begin October at a run rate of $2.3M, not $1.3M. Of the data actually captured by Symphony, the best guess annual revenue run rate for Iheezo is close to $30M as of October 1.
With September 5x higher than August, it's plainly obvious that Iheezo is off to a great start, consistent with perhaps $50M to $100M in revenue in 2024 and ramping up from there. Notably, Iheezo revenue in 2024 may exceed the revenue of the entire company in 2022.
BPP acquisition costs are $155M so far
HROW acquired Iheezo , Vevye , the " Fab 5 ", and Santen's Branded Ophthalmic Portfolio . HROW also developed a new drug called Fortisite. Each drug has a unique investing thesis - I've discussed these drugs previously - but I don't plan on getting into the details in this article.
Instead, I note that the total paid so far for these drugs is about $155M. That's $130M for the Fab 5, and $8M each for each of the rest. The deals call for royalties ranging from zero to 12% of sales, and milestone payments totaling another $55M if certain conditions are met.
BPP revenue implied by guidance
Revenue in the table below is as reported where available, and is my estimate of revenue implied by midpoint 2023 guidance otherwise, all numbers are in :
Q1 | Q2 | Q3 | Q4 | Total 2023 | |
Total | 26.1 | 33.5 | 37.6 | 41.8 | 139.0 |
Legacy | 20.4 | 21.2 | 22.1 | 22.8 | 86.5 |
BPPs | 5.7 | 12.3 | 15.5 | 19.0 | 52.5 |
In the table above, all 3 numbers are known for Q1. HROW reported them in the Q1 2023 10Q . We also know Q2 2023 quarterly revenue, and the total revenue for 2023 in the table is the midpoint of HROW's $135M to $143M 2023 guidance. Revenue for the legacy business has to be modeled since the company does not break it out for us. Here, I adjust for the number of days in each quarter - Q1 only has 90 days - and then I assume a Q on Q growth rate of 3%. This is consistent with management's comment that the legacy business is growing low double digits, and also consistent with the growth rate from Q4 2022 to Q1 2023.
By the way - and I worry I may be getting too deep in the weeds here - we really only have two "clean" quarters to look at the legacy business revenue. The reason for this is that the company divested its non-ophthalmic segment on October 5, 2022. This segment was likely responsible for about 10% of HROW's revenue in 2022. Anyone who uses total 2022 revenue of $88.6M as a starting point to estimate revenue at the legacy segment in 2023 is likely to overestimate by about 10% . I put that in bold because I think there are some folks out there doing exactly that.
Revenue in Q4 2022 is a nearly "clean" look at the legacy business, with only 5 days, or about $100k in revenue, of the divested segment. Q4 2022 ongoing revenue works out to $20.2M, compared to Q2 2023 legacy revenue, reported at $20.4M. After adjusting for the fact that there are two fewer days in Q1 than in Q4, the legacy growth rate QoQ was 3.2% in the quarter, or 13.6% annualized. I model 3% quarterly growth in the table. Again, consistent with management's commentary, and with the most recent data.
And then the BPP revenue implied by guidance, starting at $5.7M in Q1 and ramping to $19.0M by Q4, can be inferred by subtracting the legacy business revenue from the total revenue implied by guidance.
What the market is missing
It's clear that the market is either predicting a miss on guidance or hasn't done the math on what it means if the company meets guidance.
I'll begin with the math, and pound the table on the following point. If they meet guidance, HROW will have paid $155M to acquire a suite of drugs that will be producing a run rate of $76M annual revenue by Q4 2023. This is despite the fact that 3 of these acquisitions - Vevye, Triesence, and the Santen portfolio - will produce almost no revenue for HROW in 2023, and two more drugs - Iheezo and Fortisite - just launched in May! At this pace, the move into BPPs will produce more revenue than the legacy business in Q1 2024 and will be double the legacy business 12 months after that.
And it's my view that the market is absolutely missing this. There's just no way for HROW to meet guidance unless the move into BPPs is off to a great start.
And on the question of whether HROW will at least meet guidance, anyone with a Bloomberg has been thrown a serious head fake. Actually, two head fakes. The first is that Iheezo sales have been under reported. And the second is that Symphony has under reported Vigamox sales, which have instead been stable through Q2 and Q3. If one corrects for this, HROW is very much on track to at least meet guidance. And I think the market is missing this, too.
Should we even care about short-term guidance?
It's tempting to argue that paying attention to short-term guidance is not worthwhile. After all, HROW is promising us $1B of revenue in less than 5 years. Why should anyone care if revenue in 2023 is $139M or $130M or $150M? Isn't that the province of short-term speculators and stock flippers?
Well, no, actually there are two reasons for long-term investors to care. The first reason is that we can check if the move into BPPs is going well so far. HROW has done an amazing job building the legacy business, but branded pharma is not exactly the same game. And I want to know if the long term plan is on track. And if HROW meets guidance, the move into BPPs is definitely on track. There's really no way to produce the kind of revenue needed to hit guidance unless the move into BPPs is off to a great start. So that's one reason.
And the second reason is that we - I am one of those long term investors - are placing an awful lot of trust in management, and especially in CEO Mark Baum. I think this trust is merited, but when the company offers guidance, we also get one more data point to evaluate management credibility. Making or missing one quarter is certainly not definitive, but yeah, I care
HROW management's attitude toward investors
My view is that CEO Mark Baum thinks he's very shareholder-friendly, and in some ways he absolutely is. The quarterly letters are great, and so is the attitude that he considers shareholders to be his partners. He says that all the time. And they have guidance out there, which shareholders generally like, and they even share their long-range plans. It's good stuff.
But they are also walking a line between not giving away too much information to competitors and being transparent with shareholders. There's no way a private company would give away details about how a given drug is doing, but this is a public company, and there's a balance that needs to be struck.
And most investors I speak to think the company is not being transparent enough! Vevye, ok, that hasn't even launched yet, so fair enough. But the other stuff... How well is Iheezo doing? How about the Fab 4? And Fortisite? What kind of sales are they seeing at the Santen portfolio? How much Triesence do they think they can manufacture in 2024? And is the legacy business still growing?
These are questions on investors' minds. Sure, some of those investors are short-term speculators or stock flippers. But some of the same questions come up when I speak with long-term investors, from people who have placed a lot of trust in Mark and Andrew. And while it's obvious that answering each of these questions in detail might give too much information away to the competition, it would be nice to know the answer to a very important question. And that question is simply this: is the foray into BPPs working? How's it going so far? A lot depends on that.
And whether HROW thinks they've put enough out there to answer this question or not, the fact is that most investors don't feel like they know the answer. Even long-term investors I speak with don't think so.
To be clear, it's my POV that HROW management cares deeply about investors. I think they'd feel terrible if someone trusted them, invested for all the right reasons, and then got scared for all the wrong reasons, and left. Some of those investors are retail investors. And some manage money. For the latter, even long term thinkers often have to answer to someone else. An analyst at a fund has to answer to a PM. If the PM has questions that they think should be answerable, and the analyst can't answer the question? That analyst gets in trouble. And it goes that way even if it's your fund. A fund manager has to answer to investors, and some of them may want answers that the manager can't provide.
So it can be a tough ride for many investors if the right balance on disclosure remains elusive. Not just speculators. And even those long-term investors who stick it out because they trust Mark and Andrew? Well, even they might sleep better at night. Peace of mind for one's business partners is worth something in my view. And then the question is, is there any way to address this in a way that gives shareholders peace of mind AND guards the competitive position?
I suspect the company is considering this issue carefully.
Valuation
In this article, I focus on short-term indications that management can deliver on its long-term plan. That long-term plan is for $1B or more of revenue by 2027, and at very high margins. The company expects gross margins in excess of 80%, and in my view, this translates into EBITDA margins that are likely over 60%. Call it $600M or more of EBITDA, and $450M or more of fully taxed FCF. My view is that FCF will be used to repurchase shares and pay off all debt, but also that share based comp will be substantial - and well deserved! - if management can actually achieve its stated goals. Here, I model 35M shares, and FCF per share exceeding $13 by 2027. At a 15x multiple - not demanding for a fast growing debt free company - this is a $200 valuation if HROW exactly hits their $1B revenue goal. If they exceed it, and I think they will, then the share price target needs to be adjusted up from there.
Risk
In this article, I considered the short-term for HROW. Certainly over the long-term, one risk is that Iheezo, despite being off to what appears to be a great start, will suffer a reversal and fizzle out. And other drugs, such as Vevye and Triesence, which have huge potential, might for some reason not work out either. I consider the odds of failure for any of these to be quite low, and really all three would have to be abysmal failures in order for shareholders to suffer a permanent loss of capital. But it is at least possible.
Over the short term, it's always possible that HROW will miss guidance. I think the odds are good that they won't, but again, it's at least possible.
Conclusion
HROW has guided to 2027 revenue of $1B or more, and this implies huge gains for shareholders if they deliver, with a price target certainly in excess of $100, and likely much higher. Delivering on this revenue target will require the company to succeed in its bold move into branded pharmaceutical products, or BPPs. In this article, I show that early evidence is that the BPPs are off to a good start, and I also show that if the company meets midpoint guidance for 2023, BPPs would have to be ramping up aggressively, an excellent sign that management's plan is on track. Notably, there is clear and compelling evidence that the first of HROW's potential blockbuster drugs, Iheezo, is off to a terrific start.
With at least triple-digit share price coming in just a few years, the $16 share price as I write this is absurd, and the stock should be bought.
For further details see:
Implications Of Harrow's Short-Term Guidance